Returns, Dividend Or Interest?

I found that many people appear to gravitate towards ‘safe income’ producing assets, like dividend-paying stocks. A dividend strategy can generate a “permanent” (more or less) form of income which can either be reinvested to boost wealth or be consumed without really impacting already accumulated wealth.

Opting for a dividend strategy as opposed to relying on capital gains alone seems to make people less anxious in times of turmoil. This was quite evident during the recent market see-sawing (and decline). Fellow personal finance bloggers who have a dividend stock portfolio all slept really well (or so it seemed). The same can be said for those heavily involved in investing in alternative assets that produce interest.

My strategy is very different. I have only one stock (my company’s) and buy as many shares as I possibly can. It is not as crazy as it seems as I can purchase those shares for a discounted price (I participate in an employee stock purchase plan or ESPP). But am I doing the right thing? Am I brave? Or just plain stupid and exposing myself to extreme volatility? And what is it that makes a dividend strategy so interesting? Should I consider jumping onto the dividend train?

Good questions. I know (by using plain common sense) that it is risky to rely on a single stock and that I should diversify. But when and how much? And what asset classes?

In this post I will try to compare my company stock strategy with ‘safe income’ strategies like dividend-paying stock and alternative (interest paying) assets (like crowdlending).

Before continuing, note that I am comparing and evaluating my one-stock strategy and not one-stock strategies in general. I am trying to find out what is best for me considering my circumstances and not give advice on what others should do.

Anyway, let’s get started.

In the chart below you can see the hypothetical performance of my company shares (orange), dividend stocks (grey) and alternative assets (yellow). The latter could for example be crowdlending or crowdfunding.

All rates are assumed to be 4%. In other words, the return for my company shares is 4%, the return for dividend paying stocks is 4%, the dividend yield is 4% and the interest on investments in alternative assets is 4%.

Reality will be very different, but it helps shed some light on the characteristics of the different strategies.

The chart is split in two; the accumulation phase (2018 until 2027) and the withdrawal phase (from 2028 onwards).

The lines represent the total value of the investments.

The little bars represent deposits (positive) or withdrawals (negative). Note that for the company stock asset and dividend stocks asset withdrawing means selling shares. It does not include the dividend payout (for dividend stocks). Dividend payout is not visible in the chart.

During the accumulation phase the differences are not that huge (but do note that the dividend strategy outperforms the company stock strategy). The company stock and dividend stocks outperform the alternative asset due to the following reasons:

Dividend stocks pay out a dividend, which is used to buy more stocks. This boosts the growth.

I buy company shares for a discounted priced. This boosts the capital gain on my investment.

During the withdrawal phase some big differences occur:

The total values of the company stock asset and alternative assets decrease much faster than the dividend stocks.

The sole reason for this is that the dividend stocks would generate some income (in the form of dividend payouts), which would cover my expenses to some extent. In other words, I wouldn’t have to withdraw as much from my principal amount (=sell less shares).

This doesn’t apply to my company stock asset. There is no dividend payout so to cover my expenses (I’ve assumed an annual amount of $40K), I have no other option than to sell shares worth $40K.

As for the alternative assets, the interest does cover my expenses to some extent, but unlike dividend stocks that benefit from both the gain and dividend payouts, alternative assets only grow via interest. The total value shows the same decline as the value of my company stock.

That’s an eye-opener in a way. Even though I can buy company shares for a discounted price, dividend stocks appear to outperform them, especially during the withdrawal phase.

I think I begin to understand why people opting for dividend stocks are sleeping so well. Even though the gain may be low, re-invested dividend payouts can boost growth significantly. And the strategy generates a predictable (safe) income stream you can rely on during the withdrawal phase.

But I’m not done yet. I assumed all returns and yields are 4%. What would happen if I use the following rates?

Return company stock: 7%

Return dividend stock: 4%

Yield dividend stock: 4%

Interest alternative assets: 7%

The chart now looks like this.

During the accumulation phase my company stock generates more value. Due to the higher return, it also performs better than before during the withdrawal phase (although still not as good as the dividend stock asset).

The alternative asset investment is still pretty inferior to both strategies.

What it means is that my company stock could perform better, but it requires a higher return than for dividend stocks, now and in the future (when I start withdrawing).

Let’s throw in some other rates.

Return company stock:

10% during accumulation phase

4% during withdrawal phase

Return dividend stock: 4%

Yield dividend stock: 4%

Interest alternative assets: 9%

That paints a completely different picture doesn’t it?

While the company stock has great returns and outperforms the other strategies during the accumulation phase, it’s the alternative assets strategy that wins in the long run (even the dividend stocks will outperform the company stock).

Of course, this is due to the fact that I lowered the return for the company stock to 4% during the withdrawal phase. If I had set it to 7%, the company stock would see the other strategies in the rear-view mirror.

But let’s do something different and use a bad sequence of returns.

Return company stock:

4% during accumulation phase

-20%, -15%, -10%, -5%, 0% and 4% onwards during withdrawal phase

Return dividend stock:

4% during accumulation phase

-20%, -15%, -10%, -5%, 0% and 4% onwards during withdrawal phase

Yield dividend stock: 4%

Interest alternative assets: 9%

The chart now looks like this.

What this chart shows is that in the event of a bad sequence of returns, the company stock asset would lose value quicker than the dividend stock asset. Again, this is due to the fact that dividend stocks generate a dividend.

In this particular scenario, the interest generating alternative assets would clearly be the best option. It’s a non-correlated asset and is not affected (or not as much) by declines in the stock market (although even alternative assets in case of a global meltdown would be affected I guess).

Now, I can continue forever and keep adjusting the return, interest and yield rates. Any strategy can come out on top in my little game. But that’s a pretty useless exercise. The rates are pure speculation.

What isn’t speculation is the behavior. Different assets behave differently to changing market conditions.

If my company stock has a significantly higher return than the dividend stocks (now and in the future) it may outperform dividend stocks and alternative assets. But…

The company stock asset is more exposed to volatility and during the withdrawal phase there is a risk it depletes (much) faster than the dividend stocks asset (in the event returns aren’t significantly higher). Dividend-paying stocks tend to be less vulnerable to market turmoil, which could magnify the problem during a market down cycle.

As mentioned, the dividend stock strategy is less vulnerable to market fluctuations compared to my company stock. Due to the dividend payout it has the potential to cover my expenses for a longer time. It generates a ‘safe income’ stream.

If alternative asset investments can generate a consistent interest of around 9% it would be an extremely interesting strategy. It isn’t vulnerable to the same market fluctuations and has the potential to generate a stable and predictable income stream.

So what should I do? Should I stick to my current company stock strategy? Switch to dividend stocks? Or move all my money to alternative assets?

The key to answering these questions is hidden in the answers to some other questions.

What is the outlook for my company stock? For the short term and long term?

What is a realistic (and low risk) yield for dividend stocks?

What interest rate would be realistic with alternative asset investments?

What is my risk tolerance now and in the future?

As far as the last question is concerned, my risk tolerance during the accumulation phase is higher than during the withdrawal phase. During accumulation I want to expand quickly, but during withdrawal I want to be sure I have sufficient income to cover my expenses (for a certain minimum period).

It is not about having as much as possible, but about having enough for financial independence and early retirement.

I started with investing as late as 2015 and adopted a fairly aggressive (company stock) strategy in an attempt to accumulate enough wealth to make early retirement possible.

So far (and I am writing this in January 2019) this strategy has worked beautifully. The capital gain is in excess of 50%. But it is important to know the reasons:

Bull market conditions the last 3-4 years (and extra-ordinary growth for my company stock).

The possibility to obtain company shares for a discount.

But let’s compare the performance during the years 2016-2019 with the Vanguard International High Dividend Yield ETF (VYMI) and a hypothetical (9% interest) alternative asset.

VYMI is and index fund that seeks to track the performance of the FTSE All-World ex US High Dividend Yield Index. This fund has produced and average yield of around 3.5% for the last couple of years.

But let’s set it high and assume the average yield was 4.5%. Some other facts include:

I started with an investment of approximately $5K in January 2016.

I did the following additional (larger) investments: $1.8K, $13K, $11K and $10K (July 2017, January 2018, July 2018, January 2019).

Note that in the scenario’s below I’ve assumed dividend payouts of 4.5% in December 2016, December 2017 and December 2018. For these amounts new shares are bought.

The chart is an approximation (except for my company stock asset, which is a fact), but shouldn’t be too far off the truth.

In January 2019, the value of my company stock asset is $66K.

If I would have invested in the VYMI ETF instead, the value of that asset would have been approximately $40K and produce an annual dividend payout of $1.8K.

If I would have invested in alternative assets with a 9% interest, the value would have been approximately $45K and produce an annual interest payout of $4K.

The company stock strategy is clearly the best, isn’t it? Well, not necessarily.

It all depends on what you want to achieve. If the challenge had been ‘create as much wealth as you can before February 2019’, then my company stock strategy would indeed have been the best.

But a much more realistic challenge would be ‘create sufficient wealth so you can withdraw an annual income of $4K for the rest of your life’. What strategy would be best in this case? The alternative asset strategy. Clearly. It had a much lower risk all the way through and it managed to produce $4K of annual interest, so you can sit back and relax. Even the dividend strategy would perhaps be better as it produces a safe annual income of $1.8K, which at least can cover part of the required $4K.

Yes, my company stock may continue to do (much) better. But that is not the goal. And fanatically holding on to my company stock asset would mean I’d never be able to fully relax. The stock may crash for example. I’d need a daily dose of whiskey to keep me somewhat calm.

Again, it is not about creating as much wealth as possible, but to create sufficient wealth. I think that applies to all of us aspiring FIRE.

So does this mean I made the wrong decision after all? Should I sell everything today and invest in alternative assets? Or dividend-paying stocks?

If $4K annually was the goal I would probably sell today. But it isn’t. I need much more.

I am actually still quite far from reaching my goal and there is no doubt that the company stock strategy has generated more wealth than the other strategies. Even though we are in a rough patch and 2019 in no way will be as profitable as 2016-2018 (unless Trump calms down and the UK suddenly realizes the EU isn’t that bad after all and we all become friends and end all trade wars), I do expect my company stock strategy to keep outperforming the other strategies.

But (there is always a but).

My risk tolerance will shrink. No doubt about that. My liver too by the way if I drink too much (which I really don’t).

While writing this article and producing all the charts I’ve become more and more convinced that relying on my company stock strategy isn’t a good strategy in the long run for what I want to achieve.

And I begin to see visions of various early retirement portfolios.

Guaranteeing the outcome using bonds (e.g. a so called ‘bond ladder’)

Combination of stocks and bonds (like 50/50) – e.g. relying on (safe) bonds for the first x number of years and invest the rest in higher risk stocks

Dividend only (dividend stock strategy)

Alternative assets only

Combination of the above

Intuitively I gravitate towards the combo portfolio (combination of all above mentioned asset classes). This would give a lot of flexibility and provide security that my income requirements can be met regardless of the market situation.

So something like this.

10% non dividend-paying stocks – for keeping a bit of excitement (maybe I keep some company shares for nostalgic reasons)

20% Bonds

40% alternative assets (including crowdfunding of real estate)

30% dividend stocks

Why not an alternative asset only portfolio? That’s a good question and I will definitely dedicate more posts to that.

The thing is that such alternative assets have their own set of risks that are not fully understood yet. However, I have started to invest on Mintos.com (crowdlending platform), which produces an interest that exceeds 10%. Not bad. And I will continue to increase my investments in this asset. Probably even speed it up.

Sorry for the long article, but see it as an inner monologue turned post. I learned something at least. Maybe you didn’t. Maybe you think ‘what took you so long Marc?’

But I’m happy. I feel I’ve gotten some clarity on what turns to take on my journey to FIRE.

8 thoughts on “Returns, Dividend Or Interest?”

OMG, Marc! What took you so long? 😛 You’ve got to include some sort of TL;DR in these posts. It took me all day to read! 😛

Anyway, I think you’ve come to the right conclusion 😉 That being said, if I had the same opportunity as you (buy a quality tech stock at a discounted rate) I would do the same. So take what you can for now (are you planning to stay with your company indefinitey? 😉 ) and then start to diversify when you can.

Remember that your yield/interest is less important during the first years 😉 The time to play is now! 😛
My crowdlending is mostly fun and games – I wouldn’t bet on it long term to be honest. It is risky business, and the crowd real estate does take up much more time (to find the right projects to invest in), compared to the Mintos auto-investor, which you basically just set and forget. I still can’t wrap my head around the p2p lending scene. Currently I’m simply closing my eyes to the fact that I have no idea what I’m funding…I don’t think that’s going to work for me long term..

Yeah it turned out a bit long. But a brain overload is an occupational hazard when following my blog 😉
Good to read I am not entirely insane and that you would do the same if you were in my shoes. Yes, I will try to maximize the return and diversify in the years to come. I do love my job actually, so yeah no immediate plans to switch 🙂
I have some of the same considerations as you regarding the p2p lending and funding space. It all seems to work pretty well, but we haven’t seen the business under stress yet. But I think that if it runs fine for the next 4-6 years (also during an economic downturn), and the interest stays high and consistent it will build more trust.
For now I keep all my options open!

My portfolio includes both dividend paying ((a mix of stocks, investment trusts and ETFs) and non-dividend paying investments, although recently, I’ve been concentrating on the former so that I can build up the income. I don’t really see the dividends as guaranteed income as dividends can always be either cancelled or reduced. My guaranteed income will come from my final salary pension and the state pension but those won’t kick in until I’m 65/67 respectively.

Your combo portfolio looks like a good mix although that’s a big amount for alternative assets – I guess it looks big to me as I’m slowly moving away from these, still have a small amount in property crowdfunding to hoping to slowly exit, only to simply my portfolio but also for the reasons you mention, ie this industry hasn’t really been stress tested for the long term.

Good to see diversification is part of your overall strategy. I agree that dividends are not guaranteed. I guess that by picking the right ones you can be fairly certain dividend payouts will happen, but no one will guarantee it.
I also have a pension, but payouts won’t happen before I approach 70. So I need a ‘guaranteed income’ to bridge the years from early retirement until then…as a minimum. I’ll be happy if I manage to reach that within the next 7-8 years or so. And whether I end up with 40% alternative assets depends on how consistent this asset performs in the years to come and economies won’t be booming like in the past 4-5 years.

Have a great 2019 Weenie! I hope we all will make major steps towards FIRE 🙂

My close friend used to work as an investment banker for RBS in 2005. He was relocated to Hong Kong and received considerable bonuses in the form of company stock. In all his wisdom, he told me that each time he got a stock bonus he would instantly cash the stock in and reinvest in other companies. He told me that he already had too much exposure to RBS as he worked there and that if the company went bust, he wouldn’t only lose his job, he’d lose his investments too. His manager was a high roller living in a Hong Kong penthouse, he kept all of his RBS stock. We all know what happened next… In 2008 RBS lost 90% of its value. My friend lives in a £1million Wimbledon house which he paid off under the age of 37. His manager, on the other hand, went bankrupt.

Not to put you off or anything! 🙂 But you really should be careful about overexposure. Not just because it’s a single stock which could wipe out your whole net worth overnight, but also because you’re already exposed to the company because you work there. I’m all for investing in discounted company stock (I work for a FTSE 100), but I wouldn’t dream of keeping all of my eggs in one basket, all it takes is one bad person high up to bring a company down. Way too much risk!

Thanks for your feedback Nick and SavingNinja 🙂 I will definitely diversify in the years to come.
True, the fact I work for a global software tech firm that has been around for a long time helps reduce the nervousness a lot. If you’d say Microsoft will go bankrupt within 5 years no one will believe you. Maybe my employer isn’t quite the same, but not too far from it either. Never say never of course. The risk is always there. But the biggest risk with my not very diversified portfolio is that it is too vulnerable to market volatility, overexposed to the tech sector, US market, etc. That’s my main concern. But I hope to address that in the years to come 🙂

Thank SavingNinja! You are absolutely right that I am overexposed to a single stock. Not just one stock, but the stock of the company I work for. That’s a ‘single point of failure’. But to put things a bit in perspective, it is not my entire portfolio we are talking about (even though the post maybe suggests that). Holding on to this stock and buying more shares is a calculated risk that I am willing to take and is (still) well within the boundaries of my risk tolerance. But it won’t be forever. I will definitely spread out the eggs over more baskets! 🙂